Cap and Trade:

Essentials
Cap and trade is an environmental policy tool that also accurately measure and report all emissions in a timely
delivers results with a mandatory cap on emissions manner to guarantee that the overall cap is achieved.
while providing emission sources flexibility in how they
comply. Successful cap and trade programs provide strict When Is Cap and Trade Effective?
environmental accountability without inhibiting In EPA’s experience, cap and trade programs have proven
economic growth, and reward innovation, efficiency, highly successful in the context for which they are best
and early action. suited: reducing emissions on a regional or larger scale
from multiple sources that exhibit a range of control
What Is Cap and Trade? costs. While achieving significant reductions on a
Cap and trade is a policy approach for controlling large regional scale, cap and trade programs can deliver
amounts of emissions from a group of sources. The substantial air quality improvements. As effective as these
approach first sets an overall cap, or maximum amount of programs are, however, they may not be the solution to
emissions per compliance period, for all sources under the every problem. For example, eliminating localized
program. The cap is chosen in order to achieve a desired concentrations of pollution is not their primary purpose.
environmental effect. Authorizations to emit in the form of The cap and trade approach is best used when:
emission allowances are then allocated to affected sources, • the environmental and/or public health concern
and the total number of allowances cannot exceed the occurs over a relatively large area;
cap. Individual control
requirements are not specified • a significant number of
sources are responsible for
for sources; instead, sources The remarkable efficiency the problem;
report all emissions and then
surrender the equivalent and reduced costs of a cap and trade • the cost of controls varies
number of allowances at the from source to source; and
end of the compliance period.
program should not overshadow the
• emissions can be
Allowance trading enables purpose of the cap – that is, consistently and
sources to design their own
compliance strategy based on to yield public health and accurately measured.
their individual circumstances
while still achieving the
environmental results. Under the right circumstances,
overall emissions reductions cap and trade programs have
required by the cap. Affected proven extremely effective,
units can tailor their compliance plans to each source. providing substantial emission reductions, complete
Compliance strategies in well-designed cap and trade accountability and unprecedented data quality and
programs require no prior approval, allowing sources to access. Existing cap and trade programs – the Acid Rain
respond quickly to market conditions and government Program and the NOx Budget Program – have the force
regulators to remain focused on results. Sources must of federal and state standards behind them, including
national health-based air quality standards. This ensures
Power Generation SO2 Emissions that local public health needs are met in conjunction with
With and Without the achievement of regional or national emission reductions.
30
Acid Rain Program

25
Guiding Principles for
Without
Acid Rain
Program
Program Design
20
Three features critical to designing and implementing
Millions of Tons

15 Allowable environmentally effective and economically efficient trading

Emissions
Actual
programs are 1) the cap on emissions, 2) accountability,
10 Emissions
and 3) simplicity of design and operation.
5
Cap on Emissions. The cap on emissions is the central
0
element of an effective and efficient cap and trade
1980

1984

1988

1992

1996

2000

2004

2008

program. A mandatory cap on emissions is critical to

SO2 emissions have been reduced dramatically under the Acid
protect public health and the environment and to sustain
Rain Program. Early reductions under the first phase of the that protection into the future. The cap also serves to
program were banked to provide a gradual transition into the provide stability and predictability to the allowance
more stringent second phase.
Source: www.epa.gov/airmarkets
trading market.
Accountability. The accurate measurement and reporting of emissions Continued Accountability
is essential, along with the rigorous and consistent enforcement of As the cap and trade mechanism is applied to new environmental
penalties for fraud or noncompliance. Also critical is transparency, problems, EPA is very cognizant of the importance of ongoing
such as public access to source-level emissions and allowance data. assessment to ensure that environmental and public health goals are met.
The coupling of stringent monitoring and reporting requirements The remarkable efficiency and reduced costs of a cap and trade
and the power of the Internet makes it possible for EPA to provide program should not overshadow the purpose of the cap – that is, to
access to complete, unrestricted data on yield public health and environmental
trading, emissions, and compliance. results. Whether the cap has been set at
This promotes public confidence in the
environmental integrity of the program
Allowance trading enables sources a level adequate to achieve the desired
public health and environmental protec-
and business confidence in the financial to design their own compliance tions is an issue that warrants study and
integrity of the allowance market. It also evaluation. The Acid Rain Program and
provides an additional level of scrutiny strategy based on their individual the NOx Budget programs have been
to verify enforcement and encourage
compliance. Finally, accountability requires
circumstances while still achieving highly effective in reducing emissions.
Though long-term environmental
ongoing evaluation of the cap and trade the overall emissions reductions monitoring has affirmed the programs’
program to ensure that it is making effectiveness, studies have shown that
progress toward achievement of its required by the cap. further reductions in emissions beyond
environmental goal. the current caps are necessary to protect
public health and the environment.
Simplicity. Rules should be clear and easily enforced. Markets EPA continues to closely monitor and publish results, and is
function better and transaction costs are lower when rules are pursuing additional analyses of localized impacts under cap and
simple and easily understood by all participants. Moreover, the trade programs in order to help inform ongoing evaluation and
environment is more likely to be protected when rules are clear and policy making.
consistently enforced. To the greatest extent possible, simplicity should
be applied to all elements of the program, including applicability For more information, see “Tools of the Trade: A Guide to Designing
thresholds (determining which sources are affected), trading rules, and Operating a Cap and Trade Program for Pollution Control”
reporting requirements and penalty assessments. Program operation http://www.epa.gov/airmarkets/international/tools.pdf
for both emission sources and regulating authorities is more certain,
more effective, and less costly and time-consuming if the rules are
not overly complex and burdensome.

A well-designed cap and trade program delivers:

• Greater environmental protection at lower cost
• Broad regional reductions, facilitating state efforts to
address local impacts
• Early reductions, a result of allowance banking and
market incentives
• Environmental integrity and transparent operations
and results
• Fewer administrative costs to government and industry
• Efficiency and innovation incentives
• Incentives for doing better and consequences
for doing worse
• Accounting for all emissions
• Partnership with existing requirements to ensure
protection of the local population and environment.